IRS Releases New Guidance on Beginning of Construction - 23 September 2013

by Reed Smith
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Production tax credits ("PTCs") are available for wind, biomass, geothermal, landfill gas, trash, hydropower, and marine and hydrokinetic facilities, if construction of the facility begins before January 1, 2014. Alternatively, taxpayers can elect to take investment tax credit (the "ITC") in lieu of the PTC.

Notice 2013-29, issued April 15, 2013, provides guidance on what it means to begin construction for purposes of PTC and ITC qualification. In general, a taxpayer can establish that it has begun construction of a project either by starting physical work of a significant nature prior to January 1, 2014 (the "Physical Work Test"), or by paying or incurring (depending on its method of accounting), 5 percent or more of the total cost of the facility prior to January 1, 2014 (the "Safe Harbor").

Both the Physical Work Test and the Safe Harbor require the taxpayer to make continuous progress toward completion of a project once construction has begun. In the case of the Physical Work Test, the requirement is that the taxpayer must maintain a continuous program of construction (the "Continuous Construction Test"). In the case of the Safe Harbor, the requirement is that the taxpayer must make continuous efforts to advance toward completion of the facility (the "Continuous Efforts Test").

A New Safe Harbor

In response to a significant number of questions regarding the application of the Continuous Construction and Continuous Efforts Tests, on September 20, 2013, the Internal Revenue Service (the "IRS") issued Notice 2013-60, which adopts a new safe harbor providing that the Continuous Construction and Continuous Efforts Tests will be deemed to be satisfied with respect to a facility if the facility is placed in service before January 1, 2016. Although Notice 2013-60 does not provide a definition of placed in service for this purpose, existing Treasury Regulations treat property as being placed in service when it is in a condition or state of readiness and is available for a specifically assigned function. Equipment that is operational but undergoing testing to eliminate defects is considered to be in a condition or state of readiness and availability for a specifically assigned function.

In the case of power plants, the IRS has stated in a number of Revenue Rulings that the following factors are to be considered:

  • Approval of required licenses and permits
  • Passage of control of the facility to the taxpayer
  • Completion of critical tests
  • Commencement of daily or regular operation
  • Synchronization into a power grid for generating electricity to produce income
    Importantly, the IRS does not view these factors as hard and fast rules, but only as tools to be used in determining whether property is in a state or condition of readiness and is available for a specifically assigned function.

If a facility is not placed in service before January 1, 2016, the determination as to whether the Continuous Construction and Continuous Efforts Tests have been satisfied will be based on relevant facts and circumstances. In the case of the Continuous Construction Test, the requirement is that the taxpayer has a continuous program of construction that involves continuing physical work of a significant nature. In the case of the Continuous Efforts Test, Notice 2013-29 provides that ongoing efforts could include incurring additional costs in connection with a facility, entering into binding written contracts for components or for construction of the facility, obtaining necessary permits, and performing work of a significant nature.

Notice 2013-29 provides that disruptions as a result of factors that are outside the taxpayer’s control generally will not prevent the taxpayer from satisfying the Continuous Construction or Continuous Efforts Tests. Examples of such disruptions include, but are not limited to: (a) severe weather conditions; (b) natural disasters; (c) licensing and permitting delays; (d) delays at the written request of a state or federal agency regarding matters of safety, security, or similar concerns; (e) labor stoppages; (f) inability to obtain specialized equipment of limited availability; (g) the presence of endangered species; (h) financing delays of less than six months; and (i) supply shortages. Presumably the relief for unanticipated disruptions is available under the facts and circumstances test, but not under the new placed-in-service safe harbor provided by Notice 2013-60.

Facility Transfers Notice 2013-60 also clarifies that the transfer of a project after construction has begun will not affect credit eligibility. Thus, if a qualified facility satisfies either the Physical Work Test or the Safe Harbor, a taxpayer that owns the facility during the 10-year period beginning on the date the facility was originally placed in service may claim the PTC with respect to the facility, even if the taxpayer did not own the facility at the time construction began. Similarly, a taxpayer that owns the facility on the date it is originally placed in service may elect to claim the ITC in lieu of PTC with respect to the facility, even if the taxpayer did not own the facility at the time construction began.

This represents a considerable liberalization of the transfer rules that applied under the cash grant system. In general, taxpayers had the ability to elect cash grant in lieu of ITC or PTC for qualified facilities if construction of the facility began before January 1, 2012 and the facility was placed in service before a specified date. Transfers of a facility after construction began would render the facility ineligible for cash grant unless the transfer satisfied certain specified tests. Specifically, under Frequently Asked Questions and Answers issued by IRS in connection with the cash grant program, transfers of energy property were permitted only if the transferor acquired property for use in a particular project and the transferor and transferee were related. Transfers of an interest in an entity that met the safe harbor were permitted only if the entity being sold had commenced development of a project as evidenced by activity such as acquiring land, obtaining permits and licenses, entering into a power purchase agreement, entering into an interconnection agreement, and contracting with an EPC contractor.

Notice 2013-60 does not distinguish between transfers of a facility and transfers of interests in an entity owning a facility, and generally provides that transfers after construction has begun will not affect credit eligibility.

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To ensure compliance with Treasury Department regulations, we inform you that any U.S. federal tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Code or (2) promoting, marketing or recommending to another party any tax-related matters addressed herein.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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